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Transfer of Shares in Private Compani

Transfer of Shares in Private Companies

by Contributed Papers | October 13, 2010 7:49 pm

Corp Law I-T ransfer of Shares in Private Companies[1] Table O f Case s 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. Babulal Choukhani v. Western India Theatres Limited, AIR 1957 Cal 709. Balwant Transport Company v. Deshpande, AIR 1956 Nag 20. Bishan Singh v. Khazan Singh, 1959 SCR 878. Chiranji Lal Jasrasaria v. Mahabir Dhelia, AIR 1966 Assam 48. Dean v. Prince, [1954]1 All ER 749. Greenhalgh v. Mallard, [1943]2 All ER 234. Harinagar Sugar Mills v. Shyam Sunder, AIR 1961 SC 1669. Hunter v. Hunter, 1936 AC 222 HL. Lyle and Scott Limited v. Scotts Trustees, [1959]2 All ER 661. Master Silk Mills Private Limited v. D.H Mehta, (1980) 50 Comp Cas 365 Guj. Moodie v. W and F Shepherd Limited, [1949]2 All ER 1044. Ontario Jockey Club v. Samuel Mcbridge, AIR 1928 PC 291. S.P Mehta v. Calico Dyeing and Printing Mills Limited, (1990) 67 Comp Cas 533 Bom. Smith and Fawcett Ltd. Re, [1942]1 All ER 542. Tett v. Phoenix Property and Investment Company Limited, (1984) BCLC 599. Theakston v. London Trust plc., (1984) BCLC 390. V.B Rangaraj v. V.B Gopalakrishnan and Others, (1992)1 SCC 160.

Table O f Statute s 1. 2. 3. 4. 5. Companies (Amendment) Act, 1988. Companies Act, 1907. Companies Act, 1913. Companies Act, 1956. T ransfer of Property Act, 1872.

Introduction T he popular conception of a private company is that of a small concern with few shareholders, most of whom are actively engaged in managing the companys business, and who regard their shares not merely as an investment but as the source of their livelihood. In other words, a private company is visualized simply as an incorporated partnership. In fact it is often said that The soul of a private company is the Partnership Principle.[1] Private companies were for the first time recognized in England in the Act of 1907[2] and in this country in the Act of 1913.Prior to that, they were on the same footing as public companies and did not enjoy the privileges which in India were conferred on them by the Act of 1913[3] and continue to be conferred by the Companies Act, 1956. T he traditional and proverbial division of companies into public and private companies remains intact in company jurisprudence. T he distinction between private and public companies is primarily based on the idea that the legislation intends to make available the advantages of corporate trading to private traders or private persons. T hese advantages are embodied in the form of privileges which are given to private companies by the Companies Act. T he principal advantage of private companies which are usually family concerns is to secure absolute secrecy as regards their affairs and at the same time to have the liability of their members limited either by shares or by guarantee. It should be borne in mind that the main characteristic of a private company which is limited by shares, is that it cannot invite the public to subscribe to its shares or accept deposits from the public. Usually all its shares are held by a few persons who are, more often than not, members of the same family.[4] Section 3(1)(iii) of the Companies Act, 1956 defines a Private Company as : Private company means a company which has a minimum paid up capital of one lakh rupees or such higher paid up capital as may be prescribed , and by its articles,(a) restricts the right to transfer its shares, if any; (b) limits the number of its members to fifty not including (i) persons who are in the employment of the company; and (ii) persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased; and (c) prohibits any invitation to the public to subscribe for any shares in, or debentures

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Transfer of Shares in Private Compani

(d) prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives Provided that where two or more persons hold one or more shares in a company jointly, they shall, for the purposes of this definition, be treated as a single member. In view of this definition a private company is required by law and must, in its Articles of Association, incorporate the said restrictions, prohibitions and limitations. Sub-section (3) of Section 27 further endorses this point by stating that a private company limited by shares must have articles containing restrictions, limitations and prohibitions required by Section 3(1)(iii) and other private companies ie. private companies not having share capital must have in its articles the limitations and prohibitions contained in clauses (b) and (c) of Section 3(1)(iii). T hus the main characteristics of private companies are: Restrictions on the rights of its members to transfer their shares Limitation of the number of members to a certain figure. A prohibition of invitation to the public to subscribe to the shares or debentures of the company and prohibition of accepting deposits from the public. T he modern private company serves two purposes:[5] Firstly to enable small traders or private persons carrying on a family business to avail themselves of the advantages of corporate trading and, secondly to act as a subsidiary in a group of companies which help them to avoid the strict requirements imposed on public companies. T he limitations, prohibitions and restrictions required to be observed by private companies are what enable such companies to meet their goals and purposes for which they are set up. A private company by law has to incorporate into its articles restrictions on the rights of it members to transfer their shares.[6] T his feature is something intrinsic to a private company and differentiates it from public companies which have no restrictions on the rights of their members to transfer their shares. T hese restrictions on transfer of shares in private companies flow from the Partnership Principle which is the soul and basis of private companies. In order to understand and analyse T ransfer of Shares in Private Companies the focus has to be on the Restrictions on T ransfer of Shares in these companies. T his project will go on to explore the rationale for such restrictions, types of restrictions and other important related issues which stem from restrictions on transfer of shares in private companies. Re se arch Me thodology

Aims and Objectives

T he aim of this project is to perform a comprehensive study and analysis of T ransfer of Shares in Private Companies. T he project seeks to analyse and explain the various statutory provisions relating to the T ransfer of Shares in Private Companies, the rational for restrictions on the transfer of shares in private companies and the implications and issues related to these restrictions. In order to achieve its objectives the project also analyses the concept of private companies and explores the meaning of transfer of a share.

Nature of Project
T he project is analytical as well as descriptive in nature. However the majority of the project is analytical in nature.

Sources of Data
T he sources of data used are secondary in nature. A host of leading textbooks on Corporate Law as well as relevant articles from leading Law Journals have been referred to. Case reporters like Supreme Court Cases, All England Law Reports, Company Cases and All India Reporter have been used.

Scope and Limitation

T he scope of this project is limited to the performance of an analysis and study of transfer of shares in private companies only. T he law relating to transfer of shares in public companies has not been explored. Moreover the American position with respect to transfer of shares in close corporations has not been looked at.

Chapterisation
Section I deals with the meaning of the word T ransfer and explores what a transfer of a share exactly entails and distinguishes a transfer of a share from a transmission of a share.

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Section II looks at restrictions on transfer of shares in private companies. It analyses the need for such restrictions and explores their validity and scope. It also analyses the various types of restrictions and the important issues related to them. Section III deals with the remedies and safeguards that are available to the aggrieved persons in the case of abuse of powers by the Board of Directors with respect to refusal to register transfer of shares. T his section also analyses whether these remedies are adequate and looks at how they are being implemented and whether they are actually helping the cause of justice. It is to be noted that all study and analysis has been performed in the light of the appropriate statutory provisions and relevant case law.

Research Questions
T he following are the research questions: What is the concept of private companies? Why are private companies incorporated? What is the difference between T ransfer of a Share and T ransmission of a share? What exactly does a transfer of a share entail? Why does a private company need to incorporate restrictions on transfer of shares in its articles? What are the various types of restrictions on transfer of shares in private companies? What are the implications and important issues related to these restrictions? What are the various remedies available to the aggrieved persons when the company refuses to register transfer of shares? Do these remedies help in providing the appropriate safeguards and protecting the interests of the shareholders, transferees and the company? What is the scope and effect of Section 111 of the Companies Act, 1956 regarding the right of a person to appeal to the Company Law Board in the case of wrongful refusal by the Board of Directors? Are restrictions on the transfer of shares in private companies actually needed? Do these restrictions serve their intended purpose?

Mode of Citation
A uniform mode of citation has been adopted throughout the course of this project. Unde rstanding Transfe r O f Share s One of the most important features of a company is that its shares are transferable. Section 82 of the Companies Act, 1956 provides that The shares or debentures or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company. T hus Section 82 empowers every shareholder to transfer his shares in the manner laid down in the Articles and in accordance with the various provisions of law. Section 82 is in keeping with the philosophy relating to transfer of shares given in Palmers Company Law where it is stated that It is well settled that unless the articles provide otherwise the shareholder has a free right to transfer to whom he will. It is not necessary to seek in the articles for a power to transfer for the Act itself gives such a power. It is only necessary to look to the articles to ascertain the restrictions, if any, upon it. Thus a member has a right to transfer his shares to another person unless this right is clearly taken away by the articles.[7] T ransfer of shares is the voluntary conveyance of the rights and possibly the duties of a member as represented in a share in the company from a shareholder who wishes to cease to be a member to a person desirous of becoming a member.[8] T hus simply a transfer of shares means a change in the ownership of the shares by the voluntary act of the parties. T ransmission of shares as distinct from a transfer of shares occurs when a change of ownership in the shares takes place, not by agreement and the voluntary action of the parties, but by the operation of the law and as a result of some other event, such as the death or insolvency of the shareholder.[9] T ransmission of shares may also take place by legislation providing for the nationalization of a particular industry. Section 109B of the Companies Act, 1956 deals with T ransmission of Shares. T he contract by which a shareholder undertakes to transfer his shares is usually a contract of sale whereby the proposed transferor agrees to sell, and the proposed transferee agrees to buy, the shares; this contract may be concluded at the stock exchange or otherwise. It is to be noted that the shares of a private company cannot be transferred at a stock exchange.[10] T he obligation to transfer shares may arise from other types of contracts and agreements too. For example, a settlor may undertake in the trust instrument to transfer specified shares to the trustees. In a contract for transfer of shares the following are usually the implied terms:[11] T hat the transferee will pay the price and that the transferor will hand over to him genuine instruments of transfer and share certificates T hat the share certificate carries the rights and interests which it purports to convey T hat there is no undertaking by the transferor that the transferee will be registered T hat the transferor will do nothing to prevent the transferee from having the transfer registered or to delay that event T hat the transferee will indemnify the transferor from any calls or liability which may arise in respect of the shares subsequent to the transfer T hese terms are usually implied in a contract providing for transfer of shares and they may be nullified by clauses which have been expressly stated in the contract. Once the contract has been entered into the transferee has an equitable title to the shares and the transferor holds them, until registration, as trustee for the transferee. However until the purchase price is fully paid the seller remaining on the register is entitled vis--vis the purchaser to

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vote in respect of the shares without respect to the wishes of the purchaser.[12] It is to be noted that a transfer is incomplete and invalid until it is registered. Pending registration, the transferee has only an equitable right to the shares transferred to him. He does not become the legal owner until his name is entered on the register in respect of these shares.[13] T hus, having understood the meaning of transfer of shares and what exactly a transfer of a share entails it is imperative to analyse restrictions on transfer of shares and related issues in order to fully comprehend transfer of shares in private companies. Re strictions O n Transfe r O f Share s In Private Companie s Section 3(1)(iii)(a) of the Companies Act, 1956 compulsorily requires private companies to impose restrictions on the transfer of shares by incorporating such restrictions in their Articles of Association. T he Companies Act, 1956 however, does not specify any particular form of restriction or prescribe the maximum extent or scope of the restriction required. T hus the restrictions may be as slight or as severe as the framers of the articles desire. T he statute merely requires that the articles of a private company limited by shares must contain restrictions on the transfer of shares. Such restrictions should be general and apply uniformly to all the shareholders and to all types of shares[14]. T hey should not exempt certain shareholders or a certain class of shares.

Restriction Not Prohibition

It is also important to see that these restrictions are not construed as a ban or a prohibition on the transfer of shares. T he Courts have consistently held that the restriction upon transfer means any restriction that will give some control to the company over transferability of shares[15]. It does not mean a prohibition on the transfer of shares. It was held in Chiranji Lal Jasrasaria v. Mahabir Dhelia[16] that a restriction which amounts to a prohibition on transfer of shares or which precludes a shareholder altogether from transferring is invalid. Moreover a prohibition on the transfer of shares will amount to violation of Section 82 of the Companies Act, 1956 and Section 6 of the T ransfer of Property Act, 1872. T herefore if a clause in the articles provides that shares are not transferable but heritable will be valid. T his is because: Shares are property and under Section 6 of the T ransfer of Property Act, 1872 prohibiting transfer of property is not allowed. T ransferability is the general nature of property and even when there is a restriction on transfer, when the person dies the restriction will not apply.

Need for Restrictions on the Transfer of Shares

In the United States of America Private Companies are referred to as Close Corporations.[17] T his term implies that private companies are closely knit family or friendly affairs. T he members of a private company are connected by bonds of kinship, friendship or similar close ties and the intrusion of a stranger as a shareholder would be felt to be undesirable unless his admission is accepted by the existing members. Some private companies are in fact so constructed so as to amount to in economic terms as nothing more than incorporated partnerships with extremely close ties between the members. T hus these restrictions are needed in order to preserve the soul of the private company ie. the partnership principle. T hese restrictions on transfer of shares prevent anybody or everybody from acquiring shares of the company by transfer and help to keep the close ties amongst the members intact. T hus the main reasons for which Restrictions on transfer of shares are needed in private companies are:[18] T o keep the control of the company in the hands of a small group of persons bound together by ties of friendship, kinship etc. T o ensure that shares are not transferred to persons who are unacceptable to the existing members.

Strict Construction of Restrictions

Lord Greene MR in Smith and Fawcett Ltd., Re[19] stated that In construing the relevant provisions in the articles it is to be borne in mind that one of the normal rights of a shareholder is the right to deal freely with his property and to transfer it to whomsoever he pleases and this right is not to be cut down by uncertain language or doubtful implications. Any limitation on the right of transfer must be strictly complied with. T hus as the restrictions on transfer of shares are strictly construed and wherever a certain restriction can be interpreted in several ways the narrower construction will be adopted the framers of the articles must be extremely careful in drafting the restrictions on the transfer of shares so as to prevent any injustice to the shareholders.[20] T he courts should not always literally interpret the restrictions as sometimes a literal interpretation of these restrictions can defeat the very purpose of the restrictions contained in the articles. In V.B Rangaraj v. V.B Gopalakrishnan and Others[21] the Supreme Court of India held that: Shares are movable property and their transfer is regulated by the Articles of Association of the company. T he Articles of Association are the regulations of the company binding on the company and its shareholders. T herefore, the only permissible restrictions on the transfer of shares are those which are contained in the Articles of Association. An additional restriction not contained in the articles but in a private agreement between two shareholders which places further obstacles in the way of transferability is not binding either on the company or on the shareholders. T he vendee of the shares cannot be denied the registration of the shares purchased by him on a ground other than stated in the Articles.

Types of Restrictions
Restrictions on the rights of shareholders to transfer their shares generally take two common forms:[22] a) b) Right of Pre-emption in favour of the other members Powers of the Board of Directors to refuse to register transfer of shares

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Pre-emption Clause
In Bishan Singh v. Khazan Singh[23] the Court stated that the right of pre-emption is not a right to the thing sold but a right to the offer of a thing to be sold. T he most common type of transfer restriction is the right of pre-emption. T he pre-emption clause in the articles generally provides that when a member wishes to sell some or all of his shares, he shall first offer them to the other members for purchase at a price ascertained in accordance with a formula set out in the articles, or at a fair price at which the shares are valued by the directors or by the companys auditors and he shall transfer the shares to his proposed transferee only if the other members do not exercise their right of preemption.[24] T he pre-emption clause goes a long way in ensuring that the control of the shares does not fall into the hands of undesirable persons as it ensures that the existing shareholders get the opportunity to buy the shares first. Various types of pre-emption clauses are found in the articles of private companies. Sometimes it is provided that the proposing transferor shall offer the shares first to all other shareholders rateably; sometimes he is entitled to select the shareholder to whom he wants to sell; sometimes the first offer has to be made to certain shareholders e.g. those holding founders shares; sometimes the articles provide that in certain circumstances e.g. in the case of death of a member, the surviving members or directors are obliged to acquire the deceased members shares. It is usual to supplement these pre-emption clauses with the general restriction clause by providing, for example, that after the failure of those entitled to pre-emptive rights to acquire the shares and after their subsequent offer to another person, the directors may decline the transfer[25]. T here is no doubt as to the validity of these pre-emption clauses and courts have consistently upheld the validity of the preemption clause in the article of a private company.[26] T he pre-emptive clause is brought into operation where shareholders agree to sell the shares, receive the purchase price and retain it.[27] Where the pre-emption clause provides-as is normally the case- that a share may be transferred to any member but shall not be transferred to a person who is not a member so long as any member is willing to purchase the same at the fair value, the transfer between members is completely unrestricted and does not bring into operation the provisions of the pre-emption clause.[28]

Implementation of Pre-emptive Rights

Where the articles provide a procedure for implementation of pre-emptive rights the procedure laid down has to be followed. T he procedure that is usually laid down in the articles is to require the transferor to give to the company a notice of his intention to transfer his holding and asking the company to notify the other members of the availability of the shares and the price at which they will be available to them for acquisition and the time within which they should communicate to the company their desire to purchase the proffered shares. When the articles do not provide any machinery for implementation of pre-emption rights the member who wants to transfer his shares must notify all the members of his intention to do so. He should then allow them a reasonable time to inform him of their decision.[29] A member cannot evade a provision for pre-emption in the articles by contracting to sell his shares to a third person or by executing an instrument of transfer to such a person, with the intention that the purchaser shall not apply for registration as a member, but shall rest content with the vendor holding the legal title to the shares as a bare trustee for him[30]. It has been held that a pre-emption provision was complied with where one member sold to another member even though the purchase price was paid by an outsider and the transferee was to vote at the outsiders discretion[31]. It is humbly submitted that the decision of the Court to recognize this as a valid transfer and to hold it in compliance with the pre-emptive clause is erroneous as the decision goes against the very objective of the pre-emptive clause ie. to prevent outsiders and undesirable persons from gaining control of the company. In this case although the pre-emptive provision was complied with in form it was violated in substance. T he court should have looked at the substance of the matter and not the form.

Transfers contravening pre-emptive clause

A company can reject a transfer contravening the provisions of the companys articles, but the company can waive its right and accept a contravening transfer and once it does so, it loses the right to question the validity of the transfer. Hence, a transfer contravening the articles is not a nullity or void abinitio[32]. In Tett v. Phoenix Property and Investment Company Limited[33] Justice Vinelott held that despite the disregard of the preemptive provisions there had occurred a complete and effective transfer between transferor and transferee in terms of which the equitable title passed to the latter. In this case the shares in question were sold to an outsider and a transfer deed was executed in his favour in complete disregard to the pre-emptive provisions. Some shareholders were interested in acquiring the shares but not at the price which the outsider was willing to pay. T he Court of Appeal held that the transfer was in violation of the pre-emptive provisions and the company was not compelled to accept it. T he decision of the court is praiseworthy as it recognizes the true objective of the pre-emptive clause and preserves the partnership principle in the private company. T he privacy of a close corporation is more important than the price offered by an outsider, however great such a price may be. A different decision by the Court of Appeal would have defeated the intention of the incorporators when they formed the company.

Valuation of Shares for Purpose of Pre-emptive Rights

T he articles of a private company generally provide that the price payable for the shares sold in exercise of a right of pre-emption shall be a fair price. If the pre-emption clause requires the shares which a member wishes to transfer to be offered to the other members at a fair value certified by the directors or the companys auditor, the court cannot inquire into the correctness of the valuation, unless there is evidence that it was not honestly made, or unless the person who made it set out the reasons for his valuation, and those reasons show that he did not apply the proper principles. T here is scope for judicial interference even if the person who made the valuation acted negligently by not taking relevant factors into account, by giving undue emphasis to one of those factors, or by taking irrelevant factors into account, and in that situation the transferors only remedy is to sue the person who made the valuation for the difference between the valuation and the real value of the shares as damages in an action for negligence. However if the error appears in the valuation itself, the fact that the companys articles provide that the valuation shall be final, binding and conclusive, or the fact that the shares in question have already been registered by the company in the names of the other members who have exercised their pre-emption rights on the basis of an erroneous valuation, does not prevent the member whose shares are the subject of the valuation from challenging its validity[34]. In Dean v. Prince[35] it was held that

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where under a pre-emption provision the price at which the shares must be offered to the other members is their fair value, they should be valued on the assumption that the companys business could be sold as a going concern, but if the company is insolvent or has liabilities which has made an immediate winding up or a sale of its undertaking imperative, the shares should be valued on the assumption that the companys assets will be sold piecemeal, and that nothing will be received for its goodwill. T here are certain grey areas with respect to valuation of shares for the purpose of pre-emptive provisions. Uncertainty prevails over whether any addition should be made to the value of the shares ascertained in the normal way when they carry controlling voting rights at general meetings. T he Courts have to clear the ambiguity in this regard as the question can be answered both ways. On one hand the value of the control over the company conferred by the shares is totally distinct and separate from the value of the shares ascertained with reference to the companys financial condition and thus no addition should be made to the value of the shares. On the other hand, the power to control the company is inherent in a share and thus value of the control over the company conferred by the share must form a constituent element of the value of the share. T his raises the complex question as to how should the control conferred by a share be valued?

Power of the Board of Directors to Refuse to Register Transfer of Shares

T he articles of a private company generally vest the Board of Directors with discretion with regard to acceptance of a transfer of shares. T his power vested in the Board is fiduciary in nature ie. it must be exercised in good faith and for the benefit of the company and not for some extraneous purpose[36]. T he consequences and implications of the directors abusing this power and the remedies available to the aggrieved persons have been dealt with in the next section of this project.

Exercise of Power of Refusal

T he directors must exercise their right to decline registration to a transfer of shares only by passing a resolution to that effect; mere failure, due to a deadlock or something, to pass a resolution is not a formal, active exercise of the right to decline and therefore the applicant will be entitled to be registered as a member of the company. In Moodie v. W & F Shepherd Limited[37] the Board comprised of two directors ne agreed to grant the transfer while the other refused. It was held that the deadlock did not imply that the transfer had been declined and therefore the Court directed that the applicant must be registered as a member of the company.

Burden of Proof
T he burden of proving that the Board of Directors have wrongfully approved or disapproved transfers of shares rests on the person making that allegation. T he Courts will always presume bona fide on the part of the Board of Directors.[38] T ime Within Which T he Directors Should Exercise T he Power of Refusal to Register T ransfer of Shares According to Section 111(1) of the Companies Act, 1956 the Board of Directors must exercise their power of refusal within two months from the date of receiving the application. T he question that now arises is that if the directors do not exercise their power of refusal then on the expiry of the two months does the company lose the right of rejection and the transferee get a vested right to get himself registered? Section 111 is silent regarding this question. When faced with this question the Bombay High Court[39] did not agree that the company would lose the right of rejection or the transferee would acquire a vested right to the shares. It is felt that in such cases a court order would be necessary and the court should decide the matter on merits. Judicial decisions have determined that the power of refusal must be exercised within a reasonable time and the period of two months prescribed by Section 111 is reasonable. T he transferee has to silently sit through the period of two months which is given to the board to make their decision and the transferee cannot resort to any proceedings until the two-month period has expired. A belated exercise of the power of refusal will strengthen the position of the aggrieved transferee as delay in exercise of the power of refusal will be looked at with suspicion and the delay on the part of the Board in making their decision will be construed in favour of the transferee in a court of law. Abuse O f Powe r O f Board O f Dire ctors To Re fuse To Re giste r Transfe r O f Share s- Re me die s Private companies are required by law to incorporate into their articles restrictions on the transfer of shares. A common form of these restrictions is the power conferred on the Board of Directors to refuse to register a transfer. Very often the articles of a private company may vest absolute discretion in the directors to refuse to register transfer of shares. In Balwant Transport Company v. Deshpande[40] the Nagpur High Court felt that the Court would not be justified in interfering with the discretion of the directors. T he directors must exercise their discretion bona fide in what they consider-not what a court may consider-is in the interest of the company. And if they have done that the court cannot substitute their judgment for theirs.[41] However the Board of Directors does not always exercise its powers of refusal in good faith or bona fide. T he Board knows that the Courts will not interfere with their decision if they act bona fide and in the interests of the company. T hus in the name of acting in the interests of the company the Board may abuse its power and refuse to register transfer of shares according to their whims and fancies. In a private company the directors will be able to abuse this power vested in them more easily as they are usually bound by close ties of kinship, friendship etc. and thus may conspire to refuse to register a transfer for personal reasons such as hostility towards the transferee and use the defence of acting in the interests of the company as a shield. Such acts may prejudice the interests of genuine transferees and shareholders and might also affect the interests of the company adversely. Section 111 of the Companies Act, 1956 prevents the Board of Directors from abusing the power of refusal to register transfer of shares granted to them by the articles of the company and ensures that the interests of genuine and bona fide transferees and shareholders are not prejudiced or harmed in any way. Section 111 provides a right of appeal to the Company Law Board in respect of refusal to register transfer/transmission of shares and Section 111A gives the right to petition the Company Law Board for rectification of register of members. T hus a right to appeal to the Company Law Board under Section 111 will usually lie on the following grounds.[42]

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When the Board of Directors acts mala fide

Where it is proved that the Board has not exercised its power of refusal to register transfer of shares in good faith or for the benefit of the company an appeal may lie to the Company Law Board. T he power of declining a transfer is vested in the Board of Directors for the purpose of protecting the interests of the company. Hence their refusal must appear to have proceeded out of an honest and genuine desire to benefit the company. A mala fide refusal to register a transfer will not be sustained. T hus if the if the Board exercises its power of refusal in order to prevent the transferor from selling his shares at all, or because of their hostility towards him or because the Board of Directors wish to gain control of the company themselves and they consider acquisition of the shares by the transferee may prevent them from doing so the court will order the Board to register the transfer of shares[43]. In Harinagar Sugar Mills v. Shyam Sunder[44] the Supreme Court stated that while exercising its appellate jurisdiction under Section 111 the Company Law Board has to decide whether in exercising their power the directors are acting, oppressively, capriciously, or corruptly or in some way mala fide.

Inadequacy of Reasons
Earlier, Courts usually did not ask the Board of Directors to furnish reasons for their refusal to register transfer of shares. Only if the Board voluntarily disclosed its reasons the court had the power to look into them and if they did not seem to be sufficient to justify their decision the court might set it aside. However now, by virtue of the 1988 Amendment, the Board of Directors is bound by law to disclose its reasons for refusing to register a transfer of shares. T his gives an opportunity to the Company Law Board to examine the relevancy of the reasons and make its decision in a more judicious fashion. It is also in keeping with the principles of natural justice.

Irrelevant Considerations
Lord Greene MR in Smith and Fawcett Ltd., Re[45] stated that The directors (in refusing a transfer) must have regard to those considerations and those considerations only which the articles on their true construction permit them to take into consideration. T he power of refusal by the directors should be exercised strictly on the grounds specified in the articles. No other ground can be imported into the matter. A refusal is liable to be struck down if it proceeds on grounds extraneous to the articles. In Master Silk Mills Private Limited v. D.H Mehta[46] the Board of Directors refused to accept a transfer in favour of a company whereas the articles empowered them to exclude only undesirable persons. T hus the Calcutta High Court held that such blanket ban on admission of companies was beyond the authority vested in the Board of Directors by the articles. T he Court stated Approval of the transferee means approval of the transferee personally as distinguished from laying down a general rule that no corporate body would be allowed to join the company as a shareholder. T he reasoning of the Calcutta High Court is extremely well analysed and reasoned and clearly lays down the principle that if the directors exceed the power of refusal granted to them by the articles the court will strike down their order refusing to register transfer of shares. T hus under no circumstance should the Board exceed its powers and refuse to register a transfer on grounds which are outside the purview of the articles. It is thus seen that the Companies Act, 1956 has provided adequate remedies and safeguards to the aggrieved transferee and shareholder in the case of wrongful refusal to register transfer of shares by the Board of Directors. T he Company Law Board has been vested with the appropriate judicial teeth in order to mete out justice and remedy wrongful refusals by the Board. T he Courts too have implemented the law zealously and interpreted the legislative provisions in their true spirit in order to see that justice is not denied and rights of the Company, shareholder and the injured transferee are not affected adversely. Conclusion T he core issue with respect to transfer of shares in private companies is the restrictions on transfer of shares which a private company must incorporate into its articles. Section 3(1)(iii)(a) of the Companies Act, 1956 requires every private company to incorporate restrictions on the transfer of shares in its articles. It must be noted that the Section does not specify as to what these restrictions should be. It is thus open to the framers of the articles as to how many restrictions there should be and what should be their scope and extent. T he framers of the articles can make the restrictions as lenient or as strict as they desire. T he law merely requires that these restrictions on the transfer of shares should be present in the articles of association of a private company. Having restrictions on the rights of its members to transfer their shares is one of the main characteristics of a private company and is considered something intrinsic to a private company. A private company is based on the partnership principle. In fact it is said that the partnership principle is the soul of a private company. A private company is usually an association of persons bound together by close ties of kinship, friendship and sharing a camaraderie and trust which cannot be easily shared with another person. T hese restrictions on the transfer of shares in a private company help to preserve this close knit relationship amongst the members of a private company. T he restrictions on transfer of shares enable the members of a private company to prevent admission of members who may be undesirable or hostile to the existing members and also prevent dilution of control of the company. T he importance and relevance of these restrictions on the transfer of shares cannot be further emphasized. T hey virtually preserve the soul of the private company and enabler the private company to achieve its aims and objectives. T he Courts have proved to be the guardians of these restrictions and have upheld restrictions on transfer of shares in private companies in order to preserve the partnership principle in private companies. On another level these restrictions also preserve the distinction between private and public companies. It is debatable as to whether how far this distinction should be continued or maintained but that is not a relevant issue to the matter under discussion. T hese restrictions create some areas of ambiguity which create problems in company law and affairs. For example there is ambiguity with respect to valuation of shares in the case of exercise of pre-emption rights. Moreover care must be taken to see that these restrictions do not exceed their scope and extent as prescribed by the articles because if that

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Transfer of Shares in Private Compani

happens then the interests and rights of the shareholders, transferees and the company may be adversely affected. T he power vested in the Board of Directors to refuse to register a transfer is a common restriction found in the articles of a private company. T he Board often abuses this power. T he 1988 amendment which requires the Board to give reasons for its refusal has helped to check the abuse of this power. However more concrete steps need to be taken to prevent such abuse. T he remedies available in case of abuse of this power are adequately provided for by Section 111 of the Companies Act. T he Courts too have done their best to check abuse of this power and ensure that no injustice or prejudice is caused to the aggrieved person. Restrictions on the transfer of shares in private companies are thus undoubtedly extremely important and relevant. However in order to avoid the problems and ambiguities that they may create it is essential that these restrictions should be extremely well drafted with utmost care, caution and foresight. For example the scope of abuse of the power to refuse to register a transfer by the Board of Directors would be considerably reduced if proper guidelines were incorporated into the articles with respect to how the discretion and power should be exercised by the Board. Concrete steps must be taken to rectify abuse and to clear the ambiguous areas created by these restrictions on the transfer of shares in private companies. It is essential for the smooth working and success of the private company. Bibliography A. Article s 1. Avtar Singh, Company Law Annual Survey of Indian Law, Vol. XV (1979) at 43. 2. Carrie A. Platt, T he Right of First Refusal in Involuntary Sales and T ransfers by Operation of Law 48 Baylor Law Review 1197 (Baylor University, 1997). 3. N.Vijia Kumar, T ransfer of Shares SEBI and Corporate Laws, Vol. 35 (2002) at 122. 4. R.Vidhya Shankar, Scope of Power of Company Law Board T o Grant Interim Reliefs While Dealing With Petitions/Applications Under Sections 111 and 111A Of Companies Act, 1956 (2000)3 Company Law Journal at 109. 5. T homas J. Andre Jr., Restrictions on the T ransfer of Shares: A Search for a Public Policy 53 Tulane Law Review 776 (T ulane University, 1979). B. Books 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. A. Ramaiya, Guide to the Companies Act Part I 14 th ed. (New Delhi: Wadhwa and Company Law Publishers, 1998). A.K Majumdar and Dr. G.K Kapoor, Company Law and Practice (New Delhi: T axmann Publications Limited, 2000). A.L Saha, Lectures on Company Law (Bombay: N.M T ripathi Private Limited, 1990). Avtar Singh, Company Law (Lucknow: Eastern Book Company, 1999). B.K Sen Gupta, Company Law (New Delhi: Eastern Law House, 1990). Clive M. Schmitthoff, Palmers Company Law Vol. 1 (London: Steven and Sons Limited, 1976). P.B Mukharji, The New Jurisprudence (Calcutta: Eastern Law House, 1970). Paul L. Davies, Gowers Principles of Modern Company Law (London: Sweet and Maxwell Limited, 1997). Richard W. Jennings and Richard M. Buxbaum, Corporations-Cases and Materials (Minnesota: West Publishing Company, 1979). Robert R. Pennington, Company Law (London: Butterworths, 1995).

[1] Prof. M.P.P Pillais Lecture on Corporate Law on 29 th October, 2002. [2] Companies Act, 1907 ( A British Legislation). [3] Indian Companies Act, 1913. [4] A.L Saha, Lectures on Company Law (Bombay: N.M T ripathi Private Limited, 1990) at 366. [5] Clive M. Schmitthoff, Palmers Company Law Vol. I (London: Steven and Sons Limited, 1976) at 41. [6] By virtue of Section 3(1)(iii) of the Companies Act, 1956. [7] N.Vijia Kumar, T ransfer of Shares SEBI and Corporate Laws Vol. 35 (2002) at 124. [8] Supra note 5 at 386. [9] B.K Sen Gupta, Company Law (New Delhi: Eastern Law House, 1990) at 181. [10] Supra note 5 at 41. [11] Supra note 5 at 387-388. [12] Supra note 5 at 388. [13] Section 108 of the Companies Act, 1956. [14] A.K Majumdar and Dr. G.K Kapoor, Company Law and Practice (New Delhi: T axmann Publications Limited, 2000) at 33. [15] A. Ramaiya, Guide to the Companies Act Part I 14 th ed. (New Delhi: Wadhwa and Company Law Publishers, 1998) at 73. [16] AIR 1966 Assam 48. [17] Richard W. Jennings and Richard M. Buxbaum, Corporations- Cases and Materials ( Minnesota: West Publishing Company, 1979) at 367.

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[19] [1942]1 All ER 542.

Transfer of Shares in Private Compani

[18] Another reason may be to prevent key personnel or members from leaving the company.

[20] Paul L. Davies, Gowers Principles of Modern Company Law (London: Sweet and Maxwell Limited, 1997) at 345-346. [21] (1992)1 SCC 160. [22] Robert R. Pennington, Company Law (London: Butterworths, 1990) at 752. [23] 1959 SCR 878. [24] Supra note 15 at 74. [25] Supra note 5 at 394. [26] In Ontario Jockey Club v. Samuel Mcbridge, AIR 1928 PC 291 the Court held that A restriction which precludes a shareholder altogether from transferring may be invalid, but a restriction which does no more than give a right of pre-emption is valid. [27] Lyle and Scott Ltd. v. Scotts Trustee, [1959]2 All ER 661. [28] Greenhalgh v. Mallard, [1943]2 All ER 234. [29] Supra note 15 at 75. [30] Lyle and Scott Limited v. Scotts Trustees, [1959]2 All ER 661. [31] Theakston v. London Trust Plc., (1984) BCLC 390. [32] Hunter v. Hunter, 1936 AC 222 HL. [33] (1984) BCLC 599. [34] Supra note 22 at 758. [35] [1954]1 All ER 749. [36] Supra note 22 at 753. [37] [1949]2 All ER 1044. Similar views were expressed in Babulal Choukhani v. Western India Theatres Limited, AIR 1957 Cal 709. [38] Supra note 15 at 80. [39] S.P Mehta v. Calico Dyeing and Printing Mills Ltd., (1990) 67 Comp Cas 533 Bom. [40] AIR 1956 Nag 20. [41] Smith and Fawcett Ltd. Re, [1942]1 All ER 542. [42] T hese grounds have developed in the light of judicial decisions and the views expresses by the Courts. [43] Supra note 22 at 753-754. [44] AIR 1961 SC 1669. [45] [1942]1 All ER 542. [46] (1980) 50 Comp Cas 365 Guj. Endnote s: 1. Corp Law I-T ransfer of Shares in Private Companies: http://www.legalsutra.com/wp-content/uploads/2010/10/13/transfer-of-shares-inprivate-companies/Corp-Law-I-T ransfer-of-Shares-in-Private-Companies.doc No related posts. Source URL: http://legalsutra.org/265/transfer-of-shares-in-private-companies/

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